It’s All Upstream For Chevron

By: Darren Gold
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Company Profile

Chevron Corporation (CVX) is the second-largest integrated oil company in the US, after ExxonMobil Corp (XOM).   It is included in the ‘Big Oil’ category, which comprises the six largest publicly-owned oil and gas companies, namely: Exxon, Royal Dutch Shell plc (RDS.A), BP plc (BP), Total S.A. (TOT) and ConocoPhillips Co. (COP).

Chevron is involved in the exploration of oil and gas reserves, their extraction, the production and refinement of crude oil, and the marketing of petroleum products to end-users. Exploration and production (E&P) forms its upstream segment, while refining and marketing activities (R&M) are part of its downstream segment.

Note: Earnings contributions include losses not categorized in two segments mentioned above, including losses from debt financing, corporate administrative functions etc. Losses in the “All Others” head amounted to 7% of total earnings.

The following is an overview of Chevron’s financial performance:

Market Capitalization: $228bn

Revenue for fiscal year (FY) 2012:   $242bn

Revenue CAGR* (FY07-FY12): 12.1%

Earnings (FY12): $26.2bn

Earnings CAGR (FY07-FY12): 35.7%

Operating margin (FY12): 15.73%

Geographical exposure (in terms of revenues):

Exposure to liquids and gas (in terms of FY12 year-end reserves):

Integrated Oil and Gas Sub-industry Analysis

Market capitalization: $2.6tr

Revenue for last fiscal year: $4.00tr

Revenue growth (year-over-year [YoY]) : 7.23%

Note: All market capitalization, revenue and revenue growth values have been calculated using data from the top 50 oil and gas firms, ranked according to their market capitalization.

Key Players:

**The Barrel 0il- Equivalent (BOE) is a unit of energy that approximates the amount of energy released by burning one barrel of oil.

These ‘Big Four’ oil companies own around 20.3% of the total developed oil and gas reserves held by the top 33 companies in the sub-industry.

Industry Trends:

The E&P segment is integrated oil companies’ primary focus for long-term investments. Ongoing efforts to capture fossil fuels from unconventional resources have resulted in technological advancements in Enhanced Oil Recovery (EOR) techniques.

These new techniques, including ‘hydraulic fracturing’ and ‘horizontal drilling’, have enabled the extraction of oil and gas trapped in limestone formations. These developments have turned the industry’s attention to shale plays as an important future source of revenues. In the US, for example, shale gas already contributes around 34% of the total natural gas supply. EOR techniques have also resulted in enhanced recovery of oil and gas from existing fields and areas such as the Arctic.

Rising environmental awareness has become a major concern for integrated oil and gas companies. The government has recently tried to regulate greenhouse gas emissions, especially carbon-dioxide. As a result, integrated oil and gas companies are increasing their exposure to natural gas as compared to oil, because natural gas combustion releases lesser carbon-dioxide for comparable amounts of energy. The average exposure to natural gas among key players discussed in this article has risen from 29% in FY05 to 34% in FY12.

Stock Price Drivers

Crude Oil Prices:

Crude oil prices are the main revenue drivers for the upstream segments of integrated oil and gas companies like Chevron. Different benchmarks are used as a reference for crude oil prices, but prices for different companies vary depending on the quality of oil they extract. The two most widely-used benchmarks for crude oil are the price of Brent crude, which is produced in the North Sea oilfields, and the price of West Texas Intermediate, the crude oil produced in North America.

Chevron’s EPS has a high correlation of 0.92 with Brent oil prices, as displayed in the graph below.

Note: Brent crude oil is also the global benchmark for crude oil prices.

Natural Gas Prices:

Natural gas, like crude oil, is priced against a benchmark. The two main benchmarks used are the price of US Henry Hub natural gas and the price of UK Heren National Balancing Point (NBP) natural gas.

Refining Margins:

Refining margins reflect the cost of value addition to crude oil, and depend on the quality of crude oil that is refined.

Three major regions in the world lead refining activities. These include the US Gulf Coast, North West Europe and Singapore. Together, they account for 86% of the entire world’s refining throughput.

Chevron has a 50% stake in the Singapore Refining Company, which has a throughput of 290,000 barrels per day. Its EPS and the Singapore Median Sour refining margin have a correlation of about 0.60.

Source: BP Statistical Review of World Energy June 2013

Comparative Valuation

Chevron’s earnings growth is the highest amongst the four companies. Its EPS and dividends per share  are the highest as well. With a lower than average P/E multiple and the lowest PEG ratio, Chevron is trading at a relatively cheaper valuation than its competitors, and growth in its earnings can be bought cheaply.

Valuation Matrix

Our valuation matrix for Chevron shows different target prices at different levels of EPS with changing P/E multiples.


Chevron’s dividend yield was 3.50% in FY12. It increased its quarterly dividend from $0.90 in 1QFY13 to $1.00 in 2QFY13. This is in line with past trends: the company has increased its annual dividends for the past 26 years.

Chevron’s three-year dividend growth rate is 9.68%, while its five-year dividend growth rate is 9.20%.

Cash Dividend Coverage*:

Chevron’s cash dividend coverage ratio is around 3.83 times, which means the company has sufficient cash to cover future dividend payments.

*Cash Dividend coverage = (Net income before extraordinary items-minority interest- Preferred shares’ cash dividends)/Common shares’ cash dividends

Cash Flows:

As can be seen, Chevron’s cash flows from operations have declined from 2011, while its capital expenditures and dividend payments have increased YoY. This is in line with sell side analysts’ forecasts that Chevron will face cash flow issues going forward.

Total Debt to Equity:

Chevron’s decreasing debt to equity ratio is a positive sign, given that company, according to its Chief Financial Officer, first looks at this metric before budgeting for a share repurchase program.  Share repurchases are halted if the debt to equity ratio rises above 12%.

Share repurchases have become an important means of returning value to shareholders, and it is important for shareholders that repurchase programs continue in the future.

Dividends and Share Repurchases:

The next dividend will be declared in the last week of October 2013.

Risks Involved

Chevron’s earnings are highly correlated to the prices of oil and natural gas, and volatility in the prices of these commodities impacts its earnings.

Geo-political risks, like recent political turmoil in Egypt and Libya, also affect Chevron on three fronts: firstly, political turmoil in oil producing countries impacts oil prices. Secondly, any changes in government policies (for example higher taxes and royalty payments) in countries where Chevron operates will also affect its earnings. Finally, troublesome governments sometimes seize foreign companies’ assets, which puts a complete halt to operations and wipes out large investments overnight.

Chevron also has high exposure in deep-water drilling projects, whose costs are difficult to estimate. Its actual production costs in offshore reserves can therefore be higher than budgeted, which can lead to lower-than-expected earnings.


Notwithstanding the risks, Chevron is a buy, considering that it has demonstrated its ability to convert rising oil prices into cash flow growth. Its upstream profit margin (calculated in dollars per BOE, the industry standard) is the highest at around $23.9 per barrel.

Not only has Chevron performed well historically, it is also expected to grow in the future as it acquires more exploration blocks in different regions around the world. Moreover, the stock pays higher dividends every year. We recommend it as a buy!

*Compound Annual Growth Rate

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